March 4 (Bloomberg) -- Global investors are looking past
record household debt and falling property prices to pile into
South Korean mortgage bonds as a lack of supply in the world’s
biggest markets boosts the allure of the securities.

Korea Housing Finance Corp., the state-run home loan
provider, sold $500 million of covered bonds due September 2018
last week, according to data compiled by Bloomberg. Investors
bid for more than $1.7 billion of the securities, a form of bank
financing backed by mortgages and guaranteed by the issuer, with
buyers from Europe and the U.S. purchasing 55 percent of the
debt, said a person familiar with the matter who asked not to be
named because the details are private.

Global offerings of covered securities, a form of financing
pioneered in 18th-century Prussia, are off to the slowest start
to a year since 2009 as investors shy away from assets mired in
Europe’s fiscal crisis and banks reduce their funding
requirements. Investors are instead turning to Australia, Latin
America and South Korea, where forecast growth of 3.25 percent
in 2013 is about triple the developed-market average.

“Covered bond investors are very interested in the Asian
growth story,” said Ted Lord, the Frankfurt-based head of
European covered bonds at Barclays Plc. “If you are a German
insurance company, a French asset manager, or a U.K. pension
fund, there is an attraction to diversify and expand investment
in the region.”

Politicians in Asia’s fourth-largest economy are working on
a legal framework to spur sales of covered bonds, which
typically have higher credit ratings and pay lower premiums than
senior unsecured debt.

Global Demand

Australian lenders sold their first covered notes in 2011
after the government passed rules permitting the securities.
Chile approved legislation for the debt in September. Countries
from Singapore and Japan to Brazil and Romania are considering
covered bond rules.

Swelling household debt, of which mortgages account for
about 42 percent, is the biggest risk to Korea’s financial
system, according to a Bank of Korea survey of 90 experts and
fund managers in January. Money owed by households rose to a
record 959.4 trillion won ($884.7 billion) in December, central
bank data show.

Residential property prices have fallen for eight
consecutive months, the longest streak of declines since the
period ended January 2005, according to data compiled by Kookmin
Bank, the country’s largest mortgage lender, as of Jan. 31.
Seoul home prices dropped 2.9 percent in 2012, the most in 14
years. Almost half the nation’s 50 million people reside in the
capital and surrounding areas.

Borrowing Costs

“I don’t see imminent risks in Korea’s housing market or
household debt, but if something goes wrong with the economy and
the real estate market faces turmoil, given the high level of
household borrowing here, nothing is free from risk,” said Kim
Hyung Suk, head of the structured finance team at Korea
Investors Service Co., a unit of Moody’s Investors Service.
Covered bonds will help lenders cut foreign-currency borrowing
costs, he said.

South Korea’s cabinet passed a draft of the bill that sets
up a covered bond framework on Jan. 29. The act will be enforced
six months after gaining parliamentary approval.

The banking regulator hopes the securities will give
homeowners access to longer-term fixed-rate mortgages, reducing
the potential damage of an interest rate shock, Fitch Ratings
said in a Feb. 1 statement.

‘Big Interest’

Global offerings of covered bonds fell 24 percent last year
from a peak of 387.5 billion euros ($506.5 billion) in 2011,
according to data compiled by Bloomberg, leaving investors
searching for debt to maintain their portfolios. Residential
mortgage-backed securitizations, sales of notes that are also
supported by home loans, may slide 22 percent in Europe this
year, according to a January report from Barclays Plc.

The ratio of consumer debt to gross domestic product was
33.7 percent in Korea as of Dec. 31, compared to 88.7 percent in
the U.K. and 73.6 percent in the U.S., data compiled by the
Central Intelligence Agency show.

“There should be a big interest in non-European assets
because Europe and the U.S. are so indebted and that’s not the
case in Asia,” said Bernd Volk, head of European covered bond
research at Deutsche Bank AG. Particularly in the euro-denominated covered bond market, “you have lower supply and you
have a growing investor base so it’s obvious to me that any kind
of issuer will be able to issue, it’s only a question of spread
and rating.”

Bond Yields

Kookmin Bank, Korea’s debut issuer of the notes in 2009,
sold them under a securitization law that was designed for RMBS
rather than covered debt. KHFC differs from other Korean lenders
in that its act of incorporation supports covered bond sales. No
other lenders from the Asian nation have attempted offerings.

KHFC’s securities were priced to yield 100 basis points
more than Treasuries, data compiled by Bloomberg show. JPMorgan
Chase & Co., the largest U.S. bank by assets, priced five-year
senior unsecured notes at a 103 basis-point spread on Jan. 17.

Investors demand an average 0.98 percent to buy dollar
denominated covered bonds compared with 1.05 percent at the end
of the year, according to Bank of America Merrill Lynch U.S.
Covered Bond index. The yield investors demand to
buy the securities was as high as 7.7 percent on June 2009.

Lending Slows

Park Geun Hye, Korea’s new president, has said she’ll
revitalize the country’s economy and “normalize” the real-estate market. Mortgage lending in Korea climbed at the slowest
pace in five years in 2012, according to central bank data.

“With the weak real-estate market now, we won’t likely see
explosive demand for covered bonds from the issuers’ side at the
beginning,” said Min Dong Won, a credit analyst at Hyundai
Securities Co. “It’d definitely be a nice extra tool to have
for banks for cheaper funding, but issuance will be contained to
some extent so long as the real-estate market remains
sluggish.”

Low loan-to-value ratios provide some cushioning against
the risk of high household debt and falling property prices,
Moody’s wrote in a January report, adding that the credit
quality of mortgages will remain stable in 2013.

“Among many investors around the world, there is an upbeat
view on the Korean economy and the Korean banks,” said
Barclays’ Lord in an interview in Seoul in January. “These
investors have an interest to diversify their portfolios and are
very familiar and comfortable with the covered bond asset
class.”